Stock returns: momentum, volatility and interest rates

Various theories have been proposed to explain momentum in stock returns. We provide evidence in favor of risk-based explanations. Specifically, we construct self-financing market neutral portfolios that take long positions in past winners and short positions in past losers. We show that the return spreads between past winners and losers in the first year are driven primarily by high volatility stocks. Momentum investment strategies, which buy past winning stocks and sell past losing stocks, are significantly less profitable once we control for volatility. We also show that momentum profits appear to be associated with economic cycles as proxied by the prime rate. The momentum strategies are substantially stronger during expansions than during recessions. This is mainly due to the relatively poor performance of past losers (rather than superior performance of the past winners) during expansions.